by Dewi John.
UK equity income is a deeply unfashionable fund sector—the kipper tie and flares of the investment world.
Last year, it saw outflows of more UK investors’ cash than any other—£6.8bn. Over the five years from 2016 to 2020, outflows exceed £25bn. Equity income globally also fared badly, with Equity Global Income and Equity US Income shedding more than £1.5bn between them over 2020.
It’s not so very long ago that Equity Income UK used to vie for pole position with Equity UK in sales terms. Historically, the sector was seen as combining a defensive way of accessing equities, pushing client risk back towards the overcrowded middle ground while giving retirees a source of income through dividends. In other words, it ticked a few useful boxes from an advisor’s point of view.
Back in 2006 and 2007, as we headed towards the Global Financial Crisis, Equity Income took in £5.4bn and £4.7bn, respectively, while the same figures for Equity UK were negative £3.8bn and negative £9.3bn (chart 1). Yet, looking at the broader picture, you could ski down the trend line in Equity Income sales from then until now.
Chart 1: Equity UK and Equity Income UK Fund Flows, 2006 to 2020 (£bn)
Source: Refinitiv Lipper
Recent performance history has not been as bleak as these numbers suggest. Over the six months from the 30 September 2020 to 31 March 2021, Equity Income UK has marginally outperformed Equity UK, with average returns of 22.1% and 21.5%, respectively.
This could be supported by the outperformance of value stocks from late last year. For example, the US Russell 1000 Value index (+28.2%) outperformed the Russell 1000 Growth index (+10.7%) from October to the start of March on a total-return basis. This value rally is good for UK equities in general, as the market has a strong value tilt, and could help equity income returns in particular, as many classic value stocks are also significant dividend payers.
For example, one of the major beneficiaries of this rebound has been the JOHCM UK Equity Income fund, managed by Clive Beagles and James Lowen. Over the half year to the end of March, it has returned 46.6%, and has delivered almost 50% over the year. You get an idea of what’s driven the rally by looking at the top five holdings—BP, Anglo American, Barclays, Glencore, and Rio Tinto—classic value stocks that had lagged over previous years. The fund’s three largest sector exposures are Financials (30.9%), Materials (18.5%), and Energy (10.4%)—areas that have benefited from the expectations of broad market growth since the autumn.
What’s more, for those looking for dividend income, the UK market still beats its US and European rivals, by a constant margin (chart 2). In relative terms, therefore, the UK is still an attractive market—so long as its dividend income you’re looking for.
Chart 2: UK, US, and European Dividend Yields over 12 Months
Source: Refinitiv Datastream
Taken by itself, that doesn’t look bad enough to justify the woeful flows. However, the sector’s waning fortunes are down to more than reputational damage inflicted on it by the Woodford debacle—although that can hardly have helped—as the long-term trend in chart 1 testifies.
There have likely been a number of factors at play: investors have sought lower-volatility equity exposure through other avenues, such as Target Return (though that has been no universal panacea). Also, while dividends are bouncing back from last year’s freeze, three-quarters of the FTSE 100 payments expected to come from about 10 companies, a risk of which there is growing awareness.
But, as always, the biggest issue is performance: equity income simply hasn’t delivered as well in terms of total return when compared to other domestic equity classes (chart 3).
Chart 3: UK Equity Classification Returns—One, Three and Five Years (%)
Source: Refinitiv Lipper. Total return to 31 March 2021
We’ve included small caps as a comparator: they’re not a natural substitute for Equity and Equity Income, being more volatile and illiquid. But the other two are close substitutes, and it’s easy to see why equity income has lost out on a longer-term view. While the one-year figures flatter by excluding the Q1 2020 market collapse, the pattern is clear—equity income simply hasn’t delivered as well as ‘conventional’ equity. For example, only 12 of the 96 Equity Income UK funds with five-year histories beat the Equity UK five-year average return of 35.3%.
Investors will be waiting to see if this uptick in performance becomes an embedded trend. Six months of marginally better results isn’t enough to start a rush for equity income funds. But there are a number of things that could help. If value continues to outperform growth, that will be a tailwind for the sector. And, if the recovery beds in, this could lead to a steepening of the yield curve—a positive for banks, which are significant dividend payers.
For now, however, fashions haven’t turned, and investors are still in “wait and see” mode.
This article was first published in Investment Week
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